Taxation Rules the Day

Charlie Douglas, JD, CFP®, AEP®, Editor
Email: editor@naepcjournal.org
Phone: 404.279.7890

If taxation were a stock then its value would be soaring. While taxes have always been important to the financing of governments and to the people who pay them, they have a newfound significance. From their constitutional implications to their fiscal cliff connection, taxation issues are dominant these days.

The Power to Tax

Since the 1930s Congress has had the ability to tax and spend for the “general welfare,” well beyond the powers specifically enumerated in the Constitution.

In June the power to tax received a powerful boost when the Supreme Court upheld the Affordable Care Act as constitutional, affirming Congress’ authority to require Americans to purchase health insurance coverage. While the individual mandate requiring Americans to buy health insurance was unconstitutional under the seemingly expansive provisions of the Commerce Clause, the provisions of the law were nevertheless upheld under Congress’s ability to tax. As such, beginning in 2013, a Medicare surtax of 0.9% on wages over $200,000 ($250,000 for families) kicks in, plus a 3.8% tax on “unearned income” for the wealthy.

Of greater significance, however is the possibility that Congressional power could expand greatly by using the Taxing Clause found in Article I, Section 8. Simply, any future Congress seeking to enact legislation might do well to avoid the Commerce Clause and simply enact the legislation as a tax penalty.

Query, could the power to tax do more harm to our constitutional government than Congress’s ability stringently regulate commerce?

Taxation and the Fiscal Cliff

A lot has been written lately about the trillions of dollars in looming tax hikes and spending cuts set to begin to take effect next year that would likely cause a recession according to the Congressional Budget Office.

Although the fiscal cliff is comprised of both spending cuts and tax hikes, it is the tax hike component that is likely to account for roughly 80% of the impact of going over the cliff, where more than an estimated $500 billion could come out of the economy in 2013 according to the CBO. Such tax hikes would include the expiration of the Bush tax cuts, including subjecting the middle class to harsher effects of the Alternative Minimum Tax and the wealthy to a more punitive transfer tax as discussed below.

While going over the fiscal cliff may be necessary to begin reducing the budget deficit in earnest, economists generally agree that allowing the fiscal cliff to take effect could have a substantially negative impact on the economy in 2013. Most economists assume that the fiscal cliff, should it happen, won’t impact the economy until next year. Be that as it may, the uncertainty surrounding the fiscal cliff could present a drag on the economy later this year.

What is the most likely outcome regarding the fiscal cliff? Recent history suggests that some kind of last minute deal will be struck in Washington to leave matters as they are and to punt the issue into 2013.

Estate Taxes Uncertain Future

Currently, our wealth transfer tax system is also set to undergo a massive makeover beginning in 2013. Barring some legislative act by Congress, the favorable wealth transfer planning provisions found within the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 will terminate at year end. As enacted, the $5.12 million gift tax exclusion and generation skipping tax exemption, along with an appealing 35% combined estate, gift and generation skipping tax rate is set to expire on 12/31/2012, where after the reduced gift tax exclusions and higher transfer tax rates of the Economic Growth and Tax Relief Reconciliation Act of 2001 would apply.

President Obama has said that he would reinstate the estate tax at 2009 levels, which would result in $3.5 million estate and $1 million gift tax exclusions, and a top tax rate of 45%. Mitt Romney, on the other hand, has stated that he would repeal the estate tax altogether, but would preserve the gift tax rate at 35%.

What is the best course of conduct in this uncertain environment? Practitioners and wealthy clients alike should consider taking advantage of the generous transfer tax exclusions that are available until the end of the year. Waiting for a new transfer tax law and for “planning clarity” to come may mean losing out on the gifting window of opportunity that is available today.

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Charlie Douglas, JD, CFP®, AEP® has practiced in the business, tax, estate and financial planning areas for over 25 years. He holds a J.D. from Case Western Reserve School of Law and possesses the Certified Financial Planner® and an Accredited Estate Planner® designation. As a senior vice president for a leading global wealth management institution, Charlie specializes in comprehensive planning solutions and trust fiduciary services for business owners, high net-worth individuals and their families. Charlie is a board member of the National Association of Estate Planners & Councils (“NAEPC”) and is the current editor of the NAEPC Journal of Estate & Tax Planning.

This information is provided for discussion purposes only and is not to be construed as providing legal, tax, investment or financial planning advice. Please consult all appropriate advisors prior to undertaking any of the strategies outlined in this article, many of which may involve complex legal, tax, investment and financial issues. This communication is not a Covered Opinion as defined by Circular 230 and is limited to the Federal tax issues addressed herein. Additional issues may exist that affect the Federal tax treatment of the transaction. The communication was not intended or written to be used, and cannot be used, or relied on, by the taxpayer, to avoid Federal tax penalties.